Pajama Trading 101

Just a brief primer on what to do when the overnight S&P futures traders panic after a big down day.

1) Don't sell, and considering buying into the down move.  The selling is usually either late panic hedging by cash traders or liquidations by overleveraged traders cutting losses.  It is not fundamental selling and usually doesn't last beyond the overnight session.  In most cases, by lunch time in US hours, it has recovered all the overnight losses. 

2) Expect an overnight gap up the next day.  If the market had a big down day on Friday, then a panicky overnight session on Monday will usually lead to a short term bottom and a gap up and strong Tuesday.

These are just the basics of trading panicky markets in the S&P 500, since many haven't seen a market like this since early 2016.  This is the type of market that becomes more predictable.  A VIP market, volatility increases predictability market.

The big story on Friday was the strong nonfarm payrolls report, selling off bonds, and putting risk parity funds into a vice squeeze of pain on both sides, as stocks and bonds got crushed.  The only reason you would think that stocks would keep selling off is if you think the bonds will keep selling off.  I am not in that camp.  I believe that the selling in bonds is not fundamental, but panicky and speculative.  Sometimes fund managers sell not because they believe the fundamentals have changed, but because they have to reduce risk and therefore sell.  On top of that, you have trend following speculative flows on the sell side which exacerbate the down moves.  Even with a strong jobs report, it doesn't change the Fed's rate path, which is more dependent on inflation rather than employment.  The Fed and the market has already come to the conclusion that the job market is strong.  The only debate is whether inflation will go up or not.  And the job report did nothing to clarify that debate.

Just because I don't think bonds are going to keep selling off doesn't mean I am bullish on stocks.  I realize that stocks are in the last stages of a long bull market, and that is when volatility picks up and retail is all in.  But the top will usually not be a point, but a process.  I still believe that the market will chop around the top, and revisit 2875 and probably make marginal highs in a couple of months.  That will be the time to short.  Right now, its a time to look for panicky selling to buy dips for short term trades.  Since I have a longer term bearish view, I would urge to be cautious in buying dips until you get some serious selling, down to around 2680-2700.  There is massive support at those levels.  We can bounce hard from the overnight bottom today, into Tuesday/Wednesday, but I don't think its worthy of a big long position yet.